Keep your Eye on the Big Picture

Pamela and Mary Anne Aden, editors of The Aden Forecast, say subprime led the news last week, and they analyze the underlying problems, but with an optimistic epilogue.

Subprime mortgages make up about 25% of all mortgages, totaling about $2.5 trillion. And according to Moody's, about half of these loans are at risk of defaulting. This month, the worst real estate recession in 16 years, sent all the markets reeling as stock markets worldwide fell.

In a flight to safety, US government bonds rose. The housing slowdown, reducing demand for raw materials and metals, also put downward pressure on those markets. Risk aversion affected the currencies too, providing a good example of how one situation can spread like wildfire throughout the markets.

Home sales and prices fell further. The real estate slump is expected to continue into next year and some experts feel it could become a record bust due to high leverage, credit tightening and the massive amount of ARMs that will be reset over the next year or two, in most cases at a higher interest rate.

Foreclosures are hitting record highs. The Federal Reserve estimates that subprime mortgage losses could reach $100 billion. Last year defaults on high yield bonds fell to a 26-year low, but Standard and Poor's is now warning that it may cut its ratings on billions of dollars of bonds backed by subprime mortgages, as losses surge.

The biggest concerns, however, have involved some of Wall Street's largest investment banks. Bonds of US investment banks have lost about $1.5 billion of their face value this month. Credit ratings have dropped below investment grade and the risk of owning their bonds has soared, while stocks in these companies have dropped sharply.

No one really knows if we've seen the worst. So the big question is, would the government come to the rescue and cover the losses if push came to shove? At the very least the Fed would cut interest rates and pump out lots of money to help boost the economy. That in turn would be inflationary and this brings us full circle.

Whether the economy slows down or not, it's important to keep in mind that a slowdown could last a year or so, but it would not change the big, picture. Indications point to a period of many years ahead of rising inflation as a result of all the recent money and credit creation, along with increasing metals and commodity prices. This is all part of the 200-year commodity cycle, which is really just getting started. So far, the dynamic worldwide boom has fueled this up-move and we believe this will continue over the long-term."